Out of all my investments, the Roth IRA is my favorite account. Why? It is because I won’t have to pay any tax on the gains in this account. I don’t plan to withdraw until I’m 60 and not having to pay any tax or penalty at that point is a plus. See the end of the post for the qualification flow chart. Additionally, if we really need some money due to an emergency, I can withdraw the contribution with no penalty. The Roth IRA will also give us more tax strategy options when we finally withdraw from our retirement funds. We can avoid the higher tax bracket by mixing the withdrawals from regular and Roth IRA.
I was assuming that everyone knew how to contribute to a Roth IRA, but recently I found out that some of our readers would like more information. So today I’m going to go over how to start contributing to a Roth IRA.
Save up some money
Before investing in an IRA, you should have enough money to cover an emergency. Most experts recommend enough funds to cover 3-6 months of expenses, but even $1,000 would be helpful. Once you have an emergency fund, then you can save up some cash to put toward the Roth IRA. You probably would want to save up at least $500 to invest in the Roth IRA before opening a new account.
*Note: you can only invest “earned” income in the Roth IRA.
Decide where to open a Roth IRA account
Most financial institutions offer some kind of Roth IRA. Big banks like BofA offer CD and Money Market IRA options. These are very safe, but the rates are quite low. Personally, I don’t see the point of investing in these accounts. The big advantage of the Roth IRA is you won’t have to pay tax on the gain. If you are only making 1% (current rate) a year from your investment, the tax saving will be very small. I think it’s better to take a bit more risk and invest in the stock market with a brokerage especially if you are young and have over 20 years before retirement.
How to open an account at a brokerage
You can open an account at any brokerage, but I recommend a low fee online brokerage. I use Firstrade because their fees are low. I have been pretty happy with them so I don’t feel the need to change brokerages. Their customer service is also quite good. I have been able to get help on the phone whenever I need it. New investors should pay close attention to the mutual fund transaction fee when opening a new brokerage account. The mutual fund transaction fee is usually quite a bit higher than the stock transaction fee. For example, Ameritrade charges $49.99 to trade no load mutual funds. Firstrade charges only $9.95. It is still one of the lowest mutual fund transaction fees I’ve seen.
Fees at Firstrade
- Stocks and ETFs: $6.95
- Mutual funds: $9.95 for No-Load funds
Opening an account
You will need to gather the following information to open a new account.
- Social Security Number or Taxpayer ID Number
- Employer’s Name and Address
- Date of Birth
- Bank account and routing number (if funding electronically via ACH)
- For IRAs: Name, address, social security number, date of birth of beneficiary(ies)
Now you are ready to open a Roth IRA. Here is the first page of the application.
Select Roth IRA. I would skip Options for now. You can always add any later if you’d like. The easiest way to fund your account is through electronic funds transfer. After this, just fill out the forms. It should take around 10-15 minutes to do so.
Funding your account
You can set up auto deduction while filling out the forms or you can do it later as well. I like to transfer the maximum contribution amount ($5,500 for 2013) early in the year and invest it when there is a small pull back. For many young people, this is a lot of money to invest at once. It might be easier to set up an automatic deduction and invest only $200 per month to start.
What to invest in
For beginners, I recommend investing in low fee mutual funds or ETFs. If you add to your investment consistently over a long period of time, you should be able to make a good profit. Firstrade has a list of 10 commission-free ETFs that you can start with. If you can only add $200/month to your investment, these are great because you don’t have to pay the usual $6.95 commission to trade.
One simple strategy is to put the initial amount in IVV, IShares S&P 500 Index fund, and keep adding to it every month. Once you learn more about the stock market, you can trade these in for no fee and buy something else.
How to trade Stocks/ETFs at Firstrade
You can log on to Firstrade and click on the Trading tab up top. Then click on Stocks/ETFs right below the Trading tab. Once you are there can can buy or sell stocks and ETFs. In this example below, I asked to buy 2 shares of IVV at the price of $147.77. I can hit the preview button to see how much money it would cost or just hit the send order button to send the order.
Why I love the Roth IRA
Let’s summarize why I love the Roth IRA.
- No tax on the capital gain
- I can withdraw the contribution at any time with no penalty
- More tax options
If you don’t have a Roth IRA account yet, you should make it a priority to open one. The Roth IRA is a great deal for young folks because over 30-40 years, the earnings can easily grow larger than the original contribution. Why pay tax on these earnings if you don’t have to? Let me know if I can answer any questions. I hope this is helpful for some readers. You can see more retirement advice for young folks here.
Here is the distribution flow chart from the IRS if you want to learn more about withdrawal.
Distribution flow chart
{ 32 comments… read them below or add one }
Nice, detailed post. Currently I have my work 401k, and a brokerage account — where I invest mostly in dividend-paying stocks. I have been thinking about stopping the brokerage account contributions, and opening up a Roth instead. Being able to withdraw your contributions without any penalty is huge! And, obviously, that the gains are tax free.
Do you think that is the right way to go, Roth >>> brokerage? I’m trying to think of any downside …
-Mike
If your main goal is to save for retirement, then Roth is the way to go. With a taxable account, you’ll be paying tax on the dividend every year. If you are saving for a big purchase like a vacation or a wedding, then a taxable account will be easier.
@ RB40 you need to ensure to include that you must have EARNED income equal to the amount that you wish to contribute to a Roth IRA.
@mike I would never dump all my eggs into the 401K/IRA basket. Government can change taxation rules, withdraw rules etc and leave you in a precarious position.
I would always keep some in a regular “get to it no matter what” cash account…. the tax differential may be significant but offset that with the security of being able to access when needed…. just food for thought. Diversification rules apply.
I funded my first Roth IRA when I was 19. I wanted to buy stocks and the investment advisor told me he was amazed by what I was doing but then steered me to do the IRA. I am happy I got such good advice from him.
That’s great! We are planning to teach our kid about investment at a young age also. Hopefully he’ll have earned income by 19 and able to open a Roth IRA.
19? My 14 year old has been depositing to Roth since 2010. Babysitting brings in some big bucks in our neighborhood.
14 is awesome. I gotta push my kid to make some money.
licking and stuffing envelopes is essential to running a successful real estate rental business (hint hint) and fun for 2 year olds too… and great way to help the Baby RB40 earn some income and start their roth really early…. Something to think about…
If you’re planning to retire early, accounts that lock your money away until you’re 60 are probably not the best idea. Early retirement requires heavy investment in taxable accounts assuming that you’re planning to live off of your investment income.
401K matches offer enough incentive for me to invest in them up to the match, but otherwise I remain nonplussed.
That’s a good point. I still would like to have a big retirement fund though.
Keep in mind that retiring 100% Roth is a lost opportunity. In 2012, exemptions and the standard deduction for a couple adds to $19,500.
This means a couple with $487,500 (can we say $500K?) withdrawing 4% of the account value each year can take their withdrawal from a Traditional pretax IRA and pay no tax. For those in the 25% bracket while working, it would be a shame to get so excited about tax free Roth accounts that they miss this.
But – to add to your point, the impact of social security taxation can force the above numbers down a bit, and using the Roth to keep those withdrawals below $20,000/yr before taking social security payments is advised.
Sure, but it’s not any fun to live on $20,000 per year. I assume most people would like to have a comfortable $50,000 income in retirement. That’s pretty close to the 25% tax rate. I’ll have to reread your social security taxation article again. I forgot most of it already.
Likewise, currently $33,630 taxable amount would receive a tax of only $3,630 getting you to the $30,000. So, if you get to $1M, the person would be able to hit the $50k/yr withdrawal for 40-50 years without having a worry about running out, and paying the taxes in the 15% (after the standard deduction of $20,000 as a couple.
Technically speaking, they could withdraw $60,000/yr paying taxes and after 50 years they would just be about $0 in the account at the end of that time.
OK, I just talked myself into figuring out how to get my accounts up to $1.25M!
RTF & Chris –
If I wasn’t clear, I agree on the merits of Roth. Ideally, if the couple retires with $500K pretax, and the rest in a Roth, they will minimize their tax bill.
Chris – the way that Social Security becomes taxed creates an effectively higher set of brackets, a single retiree paying 46% while still withdrawing little enough to think she should be in the 15% bracket. This is the least understood bit of finance for most people. For how it works, see my 2 articles at Rothmania.net. I produce graphs for both single and couple, and show the assumptions I make, i.e. the social security benefit, etc. A couple hits 27.5% with 29K or so of income. Yes, I accounted for the std deduction/exemptions, etc. All numbers were produced with tax software.
I didn’t have any idea about Roth IRA. This post is a big help.
I’m glad to hear that. Let me know if I can answer any question.
Good article on top questions….from motley fool :
http://www.fool.com/Money/AllAboutIRAs/allaboutiras09.htm
Nice enough article you linked to. One note, the rule regarding AGI throttling one’s ability to convert a TIRA to Roth has been eliminated. Anyone can convert if they wish, regardless of income.
The tax laws change so quickly, it’s important to look at the date an article is published. In my own writing, I frequently mention the year and “this is for 20xx,” check the IRS web site or other media for updates.
I think a Roth might be a small part of a wiser strategy if you know how to create other places for money. But it looks good never the less.
Can I deduct the Roth IRA in my Tax Returns?
No, you can NOT deduct the Roth IRA in your tax return. The big benefit is you don’t have to pay tax on the gain later.
Getting started early and investing in a Roth IRA was probably the single best financial decision I ever made. It’s an absolute joy watching the portfolio grow and compound over time. It’s even better knowing that the gains aren’t subject to more taxation later, so just sit back and watch it multiply! Oh, and of course, keep contributing to the max each year if you can.
My Roth didn’t do well because I took on too much risk, but I’m adding to it. It’s a slow process.
I love my ROTH IRA and its one of the best financial decisions I’ve ever made. I only regret that I didn’t start earlier in life.
I started my ROTH IRA in 2012. Invested in $3,000 in a Vanguard fund.
We still have to fund my husband’s. I’m not sure if we are going to fund our ROTH IRA(s) this year. First we save for the down payment of a house, if we save above that amount, I will put it into the ROTH. Here’s to hoping.
Good luck! It’s hard to prioritize when you are young. I hope you can save up for a down payment soon and find a nice home.
My only fear (besides paying taxes up front) is that folks who have no idea about investing trade like a maniac and blow themselves up.
I’m 42 ,single,and have no 401k or IRA.
I currently make $45k a year.Have no debt and want to put as much as i can into retirement. I know i am starting way late but……
What would be the best thing to do currently.
I’m all for setting up an acct with First Trade or any similar Company.
Thanks.
You should see if your workplace has a 401k plan. If your employer match your contribution, I would invest there first.
Once you take full advantage of the employer contribution, then you probably should invest in the Roth IRA next.
Good luck! It’s never too late to start saving.
Here is my question and help would be appreciated. I am 40 and have continued to contribute the max to my traditional IRA since 1996. The value is currently 100,000.00 and I am wondering if I should stop contributing the max to the traditional IRA and instead start over with a Roth IRA and contribute the max to it each year. Here is the golden question, would it be worth missing out on the compounding effect of not contributing to the traditional IRA which currently has nice balance to instead reap the benefits of tax free investing in the Roth IRA? I am not interested in a conversion because of the tax consequences I would have to face at the time of the conversion. This is a good math problem for someone out there. Thanks and any help would be nice.
I’m late too so I don’t know if this will be seen but here goes.
I am about to get 10,000 dollars I never expected to get so I wanted to open a ROTH IRA and place it in there because I already have about 112,000 in my liquid savings. Can I place 10,000 dollars in a ROTH to start? I am confused by the limits you can contribute. Can you contribute ANY amount into it when you open it?
Hi Andrea,
There is a yearly cap and you can only contribute $5,500 in 2013 (assuming you are under 50.)
Open an account and place $5,500 to start. Save the rest in your saving account and add to the Roth IRA next year.
Hope this helps.
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